Question 1
( 5 points) In a world with no frictions (taxes, etc.), value is created by how you finance a project. True.
False.
Question 2
(5) The return of equity is equal to the return on debt of a project/firm Always true.
Never true.
Sometimes true.
Question 3
(10 points) Moogle, Inc. is in the same business as Google, Inc., but has recently retired all its debt to become an all-equity firm. Its return on equity has dropped from 12.25% to 10.60% as a result of this. Google, Inc. continues to have debt in its capital structure, and its debt-to-equity ratio is 30%. What is the return on assets of Google, Inc.(No more than two decimals in the percentage interest rate, but do not enter the % sign.) Answer for Question 3

Question 4
(10 points) Suppose CAPM holds, and the beta of the equity of your company is 2.00. The expected market risk premium (the difference between the expected market return and the risk-free rate) is 4.5% and the risk-free rate is 3.00%. Suppose the debt-to-equity ratio of your company is 20% and the market believes that the beta of your debt is 0.20. What is return on assets of your business? (No more than two decimals in the percentage interest rate, but do not enter the % sign.) Answer for Question 4

Question 5
(10 points) You are planning on opening a consulting firm. You have projected yearly cash flows of $2 million starting next year (t = 1) with a growth rate of 3% over the foreseeable future thereafter. This endeavor will require a substantial investment and you will have to convince investors to provide you the capital to do so. You will invest some of your own money, convincing other investors will of course be useful for your valuing your own investment decision. A critical piece of your analysis is figuring out the present value of the cash flows of the business. Your research has revealed the following information: similar consulting businesses equity has an average beta of 2.40 and the average debt-to-equity...

...L.Spight
FIN100 – Week 10
Integrative Case Study
Due – 9/5/10
Case Information:
You work for HydroTech, a large manufacturer of high pressure industrial water pumps. The firm specializes in natural disaster services, ranging from pumps that draw water from lakes, ponds, and streams in drought stricken area to pumps that remove high water volumes in flooded area. You report directly to the CFO. Your boss has asked you to calculate HydroTech’s WAAC in preparation for an executive retreat. Too bad, you are not invited, as water pumps and skiing are on the agenda in Sun Valley, Idaho. At least you have an analyst on hand to gather the following required information:
1. The risk-freerate of interest, in this case, the yield of the ten-year government bond, which is 6%.
2. HydroTech’s:
a. Market Capitalization (its market value of equity), $100 million.
b. CAPM beta, 1.2
c. Total book value of debt outstanding, $50 million.
d. Cash, $10 million
3. The cost of debt (using the quoted yields on HydroTech’s outstanding bond issues), which is 7%.
With this information in hand, you are now prepared to undertake the analysis.
Case Questions & Solutions for Case Questions 1 – 5
1. Calculate HydroTech’s net debt.
Total Debt = $50 million; Cash = $10 million
Net debt = Total debt – cash
Net debt = $50 million - $10 million
Net debt = $40 million...

...CASE STUDY HOMEWORK CORPORATE FINANCE
PROFESSOR: G. BERTINETTI
STUDENT Albert Maurer
1
The Situation: In 2010 a new company was created in order to enter into the food industry. They spent many months in studying the market, engineering the products and the commercial strategy, find out the production plants. At the end of 2010 the business plan is ready and the company has already participated to an exhibition where many potential customers said to be very interested to the project. The problem: A private equity institution gets in touch with the company in order to buy 30% of the company buying new shares. The company wonders about the value of such shares, that is why the company asks a consultant to provide an estimation. The business idea: To manufacture in Italy, thanks to the well-known reliable partners, in order to maintain high quality. This way the company will be the leader in the market. To create franchising shops, in order to develop the brand and the customers' loyalty. To let franchisee pay weekly only the final goods he has already sold. This way: The company knows the daily amount of sales and also the product mix. Moreover it becomes easier to modify the production and to minimize the stock. Cash-inflows get closer, while the working capital investment becomes lower with a lower customer credit risk. Financial forecast: The business plan has been developed looking at an exhaustive market analysis. Forecast data...

...How can risk influence risk premium? How are risk and return related?
Risk and return are the fundamental basis upon which investors make their decision whether or not they should invest in a particular investment. How they are related and the influence between the two, is the decision making process that all investors must weigh up. This essay will show how risk can influence risk premium, outlining their relationship and how risk and return are related.
Within any investment there is a certain amount of risk, which must be taken into account by an investor when deciding to invest. Risk is defined as the chance of financial loss or, more formally the variability of returns associated with a given asset. (Gitman, et al., 2011, p. 208) This concept in finance is the idea that all investment carries a risk, the higher the risk, the greater the return, however the adverse is also relevant, when the risk of an investment is lower the return is expected to also be lower. However, with all investment there is never a guarantee of return.
Return is the total gain or loss experienced on an investment over a given period of time. It is measured by the asset’s cash distributions plus change in value, divided by its beginning-of-period value. (Gitman, et al., 2011, p. 208) Returns on investment are...

...Question 1 - Bond Valuation
Assume the following information for bonds A and B. Both bonds have the same YTM and have semi-annual coupon payments. Bond B is currently selling at par.
Face Value Maturity Coupon Rate
Bond A 1000 30 yrs 8%
Bond B 1000 20 yrs 10%
a) What is the price for Bond B (2 pts)? What is the current yield for Bond B (2 pts)? Bond A is selling at a ________(discount /par/ premium) (2 pts).
b) Suddenly interestrates rise by 2%. The price of bond A will go________ (up/down) (2 pts).
c) The percentage change in the price of Bond B (in absolute value) will be _________ (smaller/bigger) than that of Bond A (in absolute value) (3 pts).
d) Assuming interestrates remain unchanged (after the initial 2% increase took place), what is the price of Bond B after 5 years (7 pts)?
Solution:
a) Price = 1000 since it sells at par. Current yield = Annual coupon payment / Price = 100 / 1000 = 10%. Bond A is selling at a discount.
b) down , down
c) smaller
d) 50/0.06*(1 – 1/1.06^30) + 1000/1.06^30 = $862.3517
Question 2 - Stock Valuation
XYZ Corp. sells toothpicks. The company currently has earnings per share of $8.25. The company has no growth and pays out all earnings as dividends. It has a new project which will require an investment of $1.60 per share today (at time...

...isolation may have little, or even no risk if held in a well-diversified portfolio.
b. The feasible, or attainable, set represents all portfolios that can be constructed from a given set of stocks. This set is only efficient for part of its combinations.
c. An efficient portfolio is that portfolio which provides the highest expected return for any degree of risk. Alternatively, the efficient portfolio is that which provides the lowest degree ofrisk for any expected return.
d. The efficient frontier is the set of efficient portfolios out of the full set of potential portfolios. On a graph, the efficient frontier constitutes the boundary line of the set of potential portfolios.
e. An indifference curve is the risk/return trade-off function for a particular investor and reflects that investor's attitude toward risk. The indifference curve specifies an investor's required rate of return for a given level of risk. The greater the slope of the indifference curve, the greater is the investor's risk aversion.
f. The optimal portfolio for an investor is the point at which the efficient set of portfolios--the efficient frontier--is just tangent to the investor's indifference curve. This point marks the highest level of satisfaction an investor can attain given the set of potential portfolios.
g. The Capital Asset Pricing Model (CAPM) is a general...

...Question 1
(5 points) By simply increasing the number of assets (e.g., assets > 30) in any portfolio, you can diversify your exposure to specific/idiosyncratic risk.
False.
True.
Question 2
(10) You have an equally weighted portfolio that consists of equity ownership in three firms. Firm A is trading at $23 per share and has a beta of 1.15; Firm B is trading at $16 per share with a beta of 1.60; Firm C is trading at $76 per share with a beta of 0.85. Assume ariskfreerate of 2% and market return of 7%. If each stock has a standard deviation of 40% and the stocks have a correlation of 0.20 with each other, your portfolio's expected return is closest to
7%
10%
5%
8%
Question 3
(10 points) You have a portfolio that consists of equity ownership in three firms. You own 200 shares of Euro General Stores (EGS), 450 shares of Fuerte Steel (FS) and 350 shares of Bamboo Flooring (BF). Their current share prices are $62, $73, and $12, respectively. What is the weight of FS in your portfolio? (No more than two decimals in the percentage weight, but do not enter the % sign.)
Answer for Question 3
Question 4
(10 points) With everyone nervous about their investments after the recent financial crisis, suppose a new firm, Safety Net Insurance (SNI), emerges to sell people insurance against poorly performing markets in exchange for an annual premium. As an investor in SNI, you would expect this company's share to have...

...Project vs Firm Risk and the
Impact of Leverage
The SML and WACC
§ Consider 100% equity financed firm
§ Beta = 1
E/V = 1!
D/V = 0!
§ WACC =?
E
D
WACC = × RE + × RD × (1 − TC ) = RE
V
V
WACC = Cost of equity from CAPM
[
]
WACC = RE = R f + β × E [RM ] − R f = E [RM ]
Beta =1!
2
SML and WACC
SML
Expected
Return
WACC = E[RM]
Rf
[
R f + β × E [RM ] − R f
]
β=1
Beta
3
Accept Projects Y and/or Z?
Expected
Return
IRRz
WACC = E[RM]
IRRY
SML
Z
Y
Rf
β=1
Beta
4
Accept Projects Y and/or Z?
E[R]
SML
E[RZ]
Z
WACC = E[RM]
Y
E[RY]
Rf
βY
β=1
βZ
Beta
5
Accept Projects Y and/or Z?
E[R]
SML
Incorrect
Z
WACC = E[RM]
acceptance
Incorrect
rejection
Y
Rf
β=1
Beta
6
Project Y
§ IRR of Project Y is lower than WACC
§ Project Y would be rejected based on
WACC
§ BUT: Project Y is less risky than firm as a
whole
§ Its return is higher than the expected
return from CAPM (it is above the SML)
§ Accept Project Y
7
Project Z
§ IRR of Project Z is higher than WACC
§ Project Z would be accepted based on
WACC
§ BUT: Project Z is more risky than firm as a
whole
§ Its return is lower than the expected
return from CAPM (it is below the SML)
§ Reject Project Z
8
Solutions to the problem
§ Pure play (opposite of conglomerate)
§ Use WACC of “pure play” companies in the
same industry (a...

...sell $35 million in new 10-year bonds to finance construction. Chris has entered into discussion with Kim McKenzie, an underwriter from the firm of Raines and Warren, about which bond features S&S Air should consider and what coupon rate the issue will likely have.
Although Chris is aware of the bond features, he is uncertain about the costs and benefits of some features, so he isn’t sure how each feature would affect the coupon rate of the bond issue. You are Kim’s assistant, and she has asked you to prepare a memo to Chris describing the effect of each of the following bond features on the coupon rate of the bond. She would also like you to list any advantages or disadvantages of each feature:
1. The security of the bond – that is, whether the bond has collateral. (5 marks)
2. The seniority of the bond. (3 marks)
3. The presence of sinking fund. (4 marks)
4. A call provision with specified call dates and call prices. (4 marks)
5. A deferred call accompanying the call provision. (6 marks)
6. A make-whole call provisions. (6 marks)
7. Any positive covenants. Also, discuss three possible positive covenants S&S Air might consider. (7 marks)
8. Any negative covenants. Also, discuss three possible negative covenants S&S Air might consider. (7 marks)
9. A conversion feature (note that S&S Air is not a publicly traded company).
(3 marks)...